Pay off the debt with the highest interest rate first.
Prioritize tax debt and collections
When it comes to paying off debts, you should focus on clearing tax debts and debts that are in collections. For instance, you might address tax debts owed to the IRS first because failing to pay can lead to severe consequences like wage garnishment or legal action.
But which one should you prioritise? When it comes to saving or paying off your debt, it's not as complicated as people think. The answer is simple: pay off your high-interest debts first.
Generally, it makes the most sense to pay off the highest interest rate loans first, because over time it means you pay out less in interest.
Prioritizing debt by interest rate.
First, you'll pay off your balance with the highest interest rate, followed by your next-highest interest rate and so on. As you work your way down the list, be sure to continue making the required minimum payments on all accounts.
The Best Ways to Pay Off Debt
Debt consolidation, the debt snowball method and the debt avalanche method are some of the best ways to tackle debt, especially if you have high-interest credit card balances. Here's what you need to know about how each strategy works and when to consider it.
In general, paying off your credit card debt in full is the optimal solution that preserves your credit score and history. However, it may not always be feasible to afford paying the total balance owed, especially with high interest rates compounding the problem.
The debt snowball method doesn't save as much on interest as the debt avalanche method, because it doesn't pay down higher-rate balances as quickly. But research suggests that for many people, focusing on the smallest debts first may be the most effective way to become debt-free.
Common priority debts include:
Court fines. Council Tax. Your rent or mortgage.
Good debt is money you borrow for something that has the potential to increase in value or expand your potential income. For example, a mortgage may help you buy a home that can appreciate in value. Student loans may increase your future income by helping you get the job you've wanted.
Payment history is the most important factor in maintaining a higher credit score as it accounts for 35% of your FICO Score. FICO considers your payment history as the leading predictor of whether you'll pay future debt on time.
Pay off your most expensive loan first.
Then, continue paying down debts with the next highest interest rates to save on your overall cost.
Payment history (35%)
The first thing any lender wants to know is whether you've paid past credit accounts on time. This helps a lender figure out the amount of risk it will take on when extending credit. This is the most important factor in a FICO Score.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
If you can afford to pay off your debt during the promotional APR period, a balance transfer card may be your best bet. For example, with $5,000 of debt, a six-month intro APR balance transfer card would allow you to pay off your debt interest-free with $833.33/month payments.
Here's how the debt snowball works: Step 1: List your debts from smallest to largest (regardless of interest rate). Step 2: Make minimum payments on all your debts except the smallest debt. Step 3: Throw as much extra money as you can on your smallest debt until it's gone.
Start chipping away at your highest-interest debt first.
Every dollar counts. Once you pay off that credit card or other high-interest debt, put the money you were paying on your highest interest debt—the minimum plus the little extra—towards the debt with the next highest interest rate.
Debt settlement is likely to lower your credit score by as much as 100 points or more.
Freedom Debt Relief is a legitimate debt settlement company founded in 2002. It's accredited by the Better Business Bureau (BBB) with an A+ rating and holds an accreditation from the American Association for Debt Resolution (AADR).
With the snowball method, you pay off the card with the smallest balance first. Once you've repaid the balance in full, you take the money you were paying for that debt and use it to help pay down the next smallest balance. This method costs a bit more in time and money, but it has psychological benefits.
Building up your savings each month as you pay down debt ensures you'll have funds on hand to cover unplanned expenses that would otherwise put you deeper into debt. For many, the best solution is to strike a balance between saving money and paying off debt.